Essays on the Stock Transfers

Abstract

This dissertation is comprised of two related but independent essays on stock transfers. Controlling shareholders of Korean firms usually attempt to pass on the firm to the next generation, and stock transfers are frequently used during the process of management succession. The first essay focuses on the market reaction to the stock gifts of controlling shareholders of the firms listed on Korean Stock Exchange (KRX). The second essay investigates whether the controlling shareholders of private Chaebol firms engage in income-decreasing earnings management preceding the ownership transfer events to reduce gift taxes. Below, I briefly explain the two essays in my dissertation. The first essay examines how equity market investors react to the announcement of stock gifts given by controlling shareholders. Prior literature documents evidence that controlling shareholders use their private information and discretionary power to time stock gifts at lower stock prices in order to reduce gift taxes. I observe significant positive excess returns when controlling shareholders transfer stocks to their related parties as gifts, suggesting that investors interpret stock gifts as a signal that stock prices are relatively low at the time of the transfer. The evidence implies that the disclosure of stock gifts reveals private information of controlling shareholders. In the second essay, I focus on the effect of a gift tax rule on the firms accounting decisions. Under Korean tax laws, the value of an unlisted stock is measured by the Alternative Valuation Method, which is an explicit function of earnings reported over the prior three fiscal years. Few studies examine how a valuation rule for unlisted stocks would provide controlling shareholders with tax-motivated incentives to influence the managerial decisions of firms, such as the reporting of earnings. I study hand-collected data of ownership transfer transactions (stock gifts, stock sales, and issuance of new shares) conducted by the controlling shareholders of private companies associated with Chaebols to find that firms decrease their discretionary earnings during the years used in the valuation, which is the three fiscal years preceding the year of ownership transfer. Furthermore, among the three years used to conduct valuation on the unlisted stocks, earnings management is found to be more evident in the year immediately preceding the year of the ownership transfer. In addition, I estimate the amount of tax reduction to show the economic significance of the tax planning strategy conducted by controlling shareholders to reduce gift taxes. The evidence suggests that controlling shareholders tend to use income-decreasing earnings management to reduce the personal gift tax levied on their related parties.